Debt Download
April 29, 2024

Debt Download

Welcome to Debt Download, Goodwin’s monthly newsletter covering what you need to know in the leveraged finance market. This month’s edition features an analysis by Goodwin partners Reid Bagwell and Andrew Cheng on the ever-changing liability management landscape.

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In the News

  • Volume of new issues in the broadly syndicated loan (BSL) market continued to climb in March, hitting $118.4 billion for the month, from $61.7 billion in February, according to Covenant Review. Net issuance was $21.4 billion, a 25-month high point, compared with $15.4 billion in February. Market activity remains dominated by refinancings and extensions, along with dividend recapitalizations. Borrowers with private debt continue to be lured to the lower prices of the BSL market, with $14.4 billion of private credit loans refinanced into BSLs in Q1. Strong demand was reflected in the price flex ratio, which continued to heavily favor borrowers with 47 loans tightened and only one widened in March, compared with 6.2:1 in February, as highlighted by Covenant Review. The average all-in clearing spread of single-B loans dipped to S+406 (S+392/99.6 OID) in March from S+434 (S+409/99.3 OID) in February. This is still quite favorable compared with January's S+395 (S+382/99.6). In addition, as noted by Covenant Review, average debt multiples for the quarter grew to 4.8x on average, from 4.5x in Q4.
  • For its part, the BSL market not only picked up new business but held on to $19.4 billion in amend-and-extend (A&E) transactions in March, lifting the Q1 total to a towering $59.9 billion, according to this PitchBook report. For historical perspective, from September 2021 to August 2023, A&E deals averaged $10.2 billion per month; since then, the average is $17.3 billion a month. PitchBook also finds that, surprisingly, the current fervor is during a period of high average yields-to-maturity—but the 9.2% we’re seeing in 2024 is still lower than 2023’s 9.6%. The looming maturity walls have also lowered, with 2024 maturities shrinking by $2.4 billion; 2025, $8.7 billion; and 2026, $15 billion. The amount of debt coming due in 2028 and beyond has in turn grown by $120.6 billion this year. The competition between private debt and BSLs is most pronounced in the upper market, as larger funds can offer unitranche deals that obviate the need for BSLs, according to this analysis by Private Debt Investor. Banks have responded to this by themselves offering one-stop private credit solutions, including a big bet by Goldman Sachs. Even so, BSL vs. private credit is not seen as a winner-take-all market, and synergies between the two credit providers are expected to continue. Indeed, in absolute terms, they are becoming fairly evenly matched, with $1.45 billion in BSL debt outstanding in the U.S. markets at the end of 2023 and between $1.2 trillion and $1.4 trillion for private credit. And head-to-head, in Europe at least, as of Q4 2023 private credit has outperformed the BSL market over the past five years, according to Private Debt Investor.
  • In March, defaults reached $10.2 billion, though $6.3 billion of that amount was one debtor (Lumen Technologies). After broadly climbing from 2022 to 2023, default rates began to come down in March, according to PitchBook. The trailing 12-month payment default rate on March 31 stood at 1.14%, from a recent peak of 1.75% in July, while LCD’s dual-track default rate, which incorporates distressed debt exchanges, was 4.22%, down from 4.32% in February. S&P Global Ratings’ look at March picks up on the same trend, noting that despite an uptick in defaults the landscape is generally stable and should improve by year’s end. S&P expects the defaults to crest in Q3, with the trailing-12-month high-yield default rate leveling off at 4.75% in the U.S. (from 5% in Q3 2023) and 3.5% in Europe (from 3.75% in Q3 2023).
  • Sticking with the theme of debtor distress, company-adjusted EBITDA addback has been consistently unreliable in tracking a borrower’s performance in the years following deal launch, according to S&P Global Ratings’ sixth annual analysis of the practice. In fact, S&P sees a strong correlation between higher addbacks and EBITDA-forecast misses, which includes a failure by 95% of companies to meet projections, understating debt by 2% during the life of the six-year survey and missing leveraged projections by 2.3x in the first year after deal closing. For most companies, these projections get worse in the second year. S&P notes a slight improvement in its latest survey, though it is unable to say whether this is an anomaly or a sea change. Possibly pushing against any change has been the recent rise of private credit, which so far has been moving in the opposite direction of standardized definitions (a factor that would relieve the pressure to negotiate addbacks). 
  • Quick roundup of recent new direct lender debt funds and related news:

Goodwin Insights – Liability Management Transactions

For this edition of Debt Download, Goodwin partners Reid Bagwell and Andrew Cheng review the latest trends in liability management transactions.

The last several years have seen a sustained uptick in contentious priming transactions executed by borrowers and select lenders at the expense of other creditors. Known as liability management transactions, these transactions are now often colloquially referred to as “lender-on-lender violence,” by their various underlying strategies, such as uptiering, dropdown or double-dip transactions, or by references to the first or most high-profile deal that employed these structures, such as Serta, J. Crew and Chewy. Whatever the name, these transactions have prompted significant attention from sponsors and lenders and their financial and legal advisors. Lenders have worked to plug holes in their documentation to preclude some of the liability management transaction structures, with varying degrees of success in the upper middle market and above. Meanwhile, several of these transactions have been the subject of litigation that has worked or is working its way through the courts.

Numerous potential liability management transaction structures exist, tailored to the particulars of the applicable credit documents. The most well-known forms of liability management transactions, however, rely on two key capacities under credit documents:

  • First, the ability to produce a super-priority tranche of debt, whether by taking the position that a majority of lenders has the right to vote to subordinate existing loans under a credit agreement to a new, super-priority tranche of debt (Serta and its progeny) or by moving assets into an unrestricted subsidiary that will issue new debt that is structurally senior to existing loans under a credit agreement (J. Crew-style transactions). 
  • Second, the ability to issue this super-priority tranche of debt in exchange for some, but not all, of the loans under an existing credit agreement by utilizing carve-outs to the pro-rata protections in such existing credit agreement, whether as an assignment or an open market purchase.

Liability management transactions with these components can be attractive to borrowers, providing new ways to raise capital by offering new-money lenders the opportunity to take first-priority security and move up in the payment waterfall. If debt is trading below par, liability management transactions permit borrowers to reduce their outstanding debt quantum by exchanging old debt from consenting lenders for new at below par. For lenders, these liability management transactions are attractive as a way to salvage a return on underperforming loans and/or invest opportunistically at an elevated priority. Covenant Review quantified the extent to which “in group” lenders have seen elevated recoveries in bankruptcy versus “out group” lenders. For instance, in Serta, the participating lenders had a 79.5% blended recovery against 1.5% for non-participating lenders, and in Diebold, the participating lenders recovered 100% against 38% for non-participating lenders, with other bankruptcies seeing similar breakdowns.

Many new deals are incorporating provisions to restrict or prevent well-known liability management transaction structures. Lenders have pushed language into the market to make subordinating existing tranches of debt and the liens securing such debt a sacred right, to limit the ability to contribute or otherwise transfer assets to unrestricted subsidiaries, and to prohibit non-cash pro rata exchanges.

Despite this, most debt continues to be issued and circulate under documents that do not have the full suite of lender protections.  Loans allowing majority-vote amendments of key provisions (i.e., those that do not make debt and lien subordination a sacred right) represent 57.8% of all loans in the Credit Suisse Leveraged Loan Index, according to Covenant Review. Among other known loopholes, the lack of PetSmart/Chewy protection (allowing for automatic release of guarantees and security by guarantor subsidiaries) is found in 76.5% of all loans in the Index; the J. Crew trapdoor (which allows investments made to restricted subsidiaries to be passed-through to unrestricted subsidiaries ) is a relative rarity at 6.7%; and the Envision loophole (allowing for a transfer of material assets to an unrestricted subsidiary) remains in 18.6% of loans.

Creative lenders and sponsors also continue to find new liability management transaction structures. Creditors have begun utilizing a newer form of liability management transaction referred to as “double-dips” that uses intercompany loans to multiply new lender claims. In a double-dip structure, the debtor incurs a new debt facility at a non-guarantor SPV subsidiary, which is guaranteed by the existing credit group. The new SPV borrower then lends the proceeds back to the existing credit group as a secured and guaranteed intercompany loan facility. In this structure, the new lenders gain access to the guarantees of the existing loan party-group first via the guarantees supporting the new debt and second via the credit support on the intercompany loan (which intercompany loan is itself collateral for the lenders). The new lenders obtain double the claims on each new dollar of debt extended in order to improve their position in a bankruptcy —though how bankruptcy courts will ultimately treat double-dip claims remains an open question.  Even credit documents that protect against more traditional liability management transactions rarely include protections expressly addressing double-dip transactions.

While market trends give lenders little comfort that the era of liability management transactions will soon end, some of the most high-profile liability management transactions continue to be the subject of litigation, and an adverse judgment in these cases could necessitate a change in available structures. While Texas bankruptcy courts upheld Serta’s uptiering transaction in connection with its chapter 11 case, ruling that the Serta exchange was a permitted open market purchase, the Southern District of New York declined to dismiss creditor claims that the uptiering transaction did not constitute an “open market” purchase, permitting this claim to proceed to discovery. Other courts have also permitted or signaled that they are inclined to allow similar claims to proceed to discovery, most recently  in litigation before the Supreme Court of New York challenging Mitel’s uptiering transaction.  If a court ever were to issue a decision that, for instance, the pro rata provisions in a credit agreement were indirect restrictions on subordination, or that an assignment or open market-purchase could not be structured as a debt-for-debt exchange, such a decision, more than any other factor, would likely be what restrains the future behavior of participants in the leveraged finance market.

In Case You Missed It – Check out these recent Goodwin publications: FTC Issues Final Rule Prohibiting Most Post-Employment Non-Compete Agreements; How Long Do Funds Suspend the Investment Period Due to “Key Person Events”?; Paying for Buy-Side Investment Research: Will the FCA’s Third Way Ease the US-UK Divide?; Acquiring or Investing in EU Crypto-Asset Businesses: Further Clarity on MiCA; 15 Questions Fintechs Should Ask Potential Bank Partners in Due Diligence; Delaware Supreme Court Holds That Boards Must Satisfy the MFW Framework in Controller Transactions to Obtain Business Judgment Deference; Supreme Court Rejects Securities Lawsuit Based On “Pure Omission” From SEC Filings; ‘Office Is Not Dead’, and Other Takeaways on the Real Estate Outlook


For inquiries regarding Goodwin’s Debt Download or our Debt Finance practice, please contact Dylan S. Brown, Nikolaus J. Caro, and Robert J. Stein.

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This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee a similar outcome.